Do Analysts Matter for Governance? Evidence from Natural Experiments
77 Pages Posted: 16 Nov 2012 Last revised: 5 Mar 2015
Date Written: April 21, 2014
Building on two sources of exogenous shocks to analyst coverage – broker closures and mergers, we explore the causal effects of analyst coverage on mitigating managerial expropriation of outside shareholders. We find that as a firm experiences an exogenous decrease in analyst coverage, shareholders value internal cash holdings less, its CEO receives higher excess compensation, its management is more likely to make value-destroying acquisitions, and managers are more likely to engage in earnings management activities. Importantly, we find that the most of these significant effects are mainly driven by the firms with smaller initial analyst coverage and less product market competition. We further find that after exogenous broker terminations, a CEO’s total and excessive compensation become insensitive to firm performance in firms with low initial analyst coverage. These findings are consistent with the monitoring hypothesis, specifically that financial analysts play an important governance role in scrutinizing management behavior, and the market is pricing an increase in expected agency problems after the loss in analyst coverage.
Keywords: Financial analyst, Monitoring, Natural experiment, Analyst coverage, Value of cash holding, CEO excess compensation, Acquisition, Earnings management
JEL Classification: G34, G24, G32, M12, M41
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